“The Commerce Ministry cannot raise the FDI cap without first consulting us, and we will definitely not allow 100% FDI anytime soon”, a senior MoD official told Business Standard on condition of anonymity. “We have already rejected two applications for setting up Joint Venture companies with 49% FDI. Where is the question of allowing 100% FDI?”

The first application the MoD rejected was that of a proposed JV involving Mahindra Defence Systems (74%) and UK-based BAE Systems (26%); the second rejection involved L&T (74%) and Franco-German corporation, EADS (26%).

The new Consolidated FDI Policy, effective from 1st Apr 10, enunciates the current FDI limit of 26%. But the MoCI’s Department of Industrial Policy & Promotion (DIPP) is lobbying actively for raising this limit.

The DIPP Secretary, RP Singh, explained the MoCI’s rationale to Business Standard on Saturday. “We are very focused on the defence sector. As an industry department we realise that if the defence sector is opened to FDI, its impact upon the manufacturing sector in India will be very great. Foreign defence majors will be more likely to bring in sensitive technology if you allow them higher FDI. Defence production requires technology, and also huge capital investments. If we can address security concerns, there is a chance of opening it up to 100%.”

Mr Singh revealed that the DIPP had already sent a written proposal to the MoD after preliminary discussions. The DIPP letter proposes greater foreign equity in defence JVs, but does not suggest a specific FDI level.

“Things are still at a discussion stage. Our stance will get crystallised after we discuss and only then will the Government of India change the policy”, pointed out the DIPP Secretary. “My personal view is that 100% FDI should be allowed; but all stakeholders will contribute to the final decision.”

The MoCI claims that Indian private defence manufacturers, such as L&T and the Tata Group, support the raising of FDI caps in order to allow a larger share to foreign companies. But Business Standard has learned that R&D-oriented private sector companies are apprehensive that global majors will use their Indian subsidiaries to get the MoD to fund the development of weapons systems under the “Make” category of the Defence Procurement Policy of 2008 (DPP-2008).

The DPP-2008 allows any Indian company --- and a 100% Indian subsidiary of a global major would be eligible for this --- to receive funding from the MoD for developing defence platforms under the “Make” category. The MoD has undertaken to fund up to 80% of the development cost, with the private vendor paying just 20% of the development cost.

“With defence budgets coming under severe pressure in the west, what better way of obtaining funding than setting up a 100% subsidiary in India that can draw from the Indian MoD”, asks the CEO of a prominent private sector defence company. “It would be entirely legitimate, and it would wipe out the Indian defence manufacturers entirely”.

For smaller, less R&D-oriented Indian defence manufacturers, however, a raise in FDI caps would come as a blessing. This would allow them to benefit from borrowed technology and also reduce capital costs in setting up new manufacturing units.

The MoD’s opposition, however, to increasing FDI caps stems from the fear that the entry of large private manufacturers will lead to job losses with DPSUs and Ordnance Factories. The DIPP counters that foreign vendors are likely to partner the defence public sector in setting up manufacture.

Speaking to a CII gathering on 1st April, the DIPP Secretary said, “If full investment comes here, [the foreign vendors] are not going to manufacture everything themselves. Lot of it will be outsourced from the Ordnance Factories. The kind of infrastructure that they have got… they have the best CNC machines; huge land; a good work force; only thing is that they are not in a position to source technologies from outside.”

Since 2001, when the private sector was allowed into defence manufacture, there has been a cap of 26% on Foreign Direct Investment (FDI) in defence. The government’s Economic Survey for 2008-09 had flagged the possibility of raising this to 49%. The US government and industry bodies like the US-India Business Council (USIBC) have also lobbied for raising the cap to at least 49%.